The Indian rupee slipped to a two-year low on Thursday as it crossed Rs 65 mark against the dollar. The Indian currency continued the tumble for the sixth consecutive day as domestic markets adjusted to a newer range for the currency following the devaluation of Chinese currency Yuan by the People's Bank of China.
The rupee had last crossed the Rs 65 mark in September 2013 when the country was struggling with high deficits and had gone on to test 70 to a dollar mark before it strengthened.
Though depreciation of a currency should be a welcoming news for the economy which is trying to promote its manufacturing and export sector, it comes strapped with several bad news.
Macro problem
While a weak rupee is expected to help exports, an anticipated currency war among competing exporting nations can neutralise any positive spin-offs for exporters. With Chinese economy not doing so well and the PBoC trying its best to boost exports by devaluing Yuan, Indian exports will face a tough competition as Asian countries try to devalue their currency to get a bigger share of demand.
Data released by the government for June showed exports fell for seventh straight month contracting 15.8 per cent year-on-year.
A weaker rupee would, however, spell bad news by making imports costlier and worsening the trade deficit. Weaker rupee would also negate the benefit of lower crude oil prices. While crude prices have fallen below $50 to a barrel, dollar getting expensive will hurt India's import bill. This raises the spectre of higher current account deficit.
Corporates hit
The manufacturing sector that is already struggling with weak demand would be hit by a rise in the cost of imported raw material and machinery. On the one hand this would shrink margins; it may also affect expansion plans for some companies.
Companies at large would also face the problem of servicing foreign loans as their rupee cost of paying dollar denominated returns will get pushed up. Although currency hedging may provide a cushion, given the swift movement of the rupee due to the surprise action by China may not be able to neutralise the full impact.
A weaker rupee also makes it difficult for companies to attract foreign investment.
Short or medium term investors—a scare for all
Falling rupee poses a problem for foreign investors in getting less value on their money while repatriating the money. A sudden fall affects foreign portfolio investors (FPIs) while a weak rupee over time affects even relatively longer-term investors like private equity and venture capital firms.
With the US Fed expected to raise interest rates by September, a chunk of portfolio money is already expected to flow back to safe haven assets, weakening the rupee further and leaving the markets in a panic mode. The current decline in Indian currency would hasten the process.
Meanwhile, PE and VC firms, who have seen a good chunk of their past investments vanish as the rupee slid from Rs 39-40 to a dollar during the go-go years of investment to over Rs 60, it is a further pain in an existing wound.
Given the sliding rupee, PE/VC investors would now have to factor in the higher currency risk as they sell their new India-focused funds to their own investors or Limited Partners.
RBI in a quandary
Fast depreciating currency also leaves the central bank more cautious for the future path of rate cuts, seen crucial for pump priming the economy. While the latest inflation figures do make a strong case for a rate cut, RBI may follow a more cautious approach and keep the rates on hold.
The central bank has already been doveish on future rate cuts as banks haven't been transferring the effects to the consumer. The meteorological department's forecast of below normal monsoon has kept the spectre of food price-led rise in inflation alive.
While the RBI with its forex reserves will try its best to contain the downfall of rupee like it did on Wednesday, a volatile rupee can spell trouble for the bank which may have to intervene in markets time and again to keep the currency from depreciating too fast.
Pay up more for consuming imported stuff, foreign holidays
The most direct impact would be for the consumers. The rise of dollar doesn't just negates decline in fuel prices but also pushes up the price of every imported product and even those items that are assembled from imported components. Moreover, if you have been waiting for that foreign holiday, get ready to shell out more.